FINANCIAL RATIOS AND THEIR INTERPRETATION

Different Financial Ratios

Sl.No. CATEGORY TYPES OF RATIO INTERPRETATION

Net Working Capital =  It measures the liquidity of a firm.

Current assets-current liabilities

1. Liquidity ratios
 It measures the short term liquidity of
Current ratio = a firm. A firm with a higher ratio has
better liquidity.
Current Assets
Current Liabilities  A ratio of 2:1 is considered safe.

Acid test or Quick ratio =  It measures the liquidity position of a

firm .
Quick assets
Current Liabilities  A ratio of 1:1 is considered safe.

Inventory Turnover ratio =  This ratio indicates how fast

inventory is sold.
Turnover ratios Costs of good sold
2.
Average inventory  A firm with a higher ratio has better
liquidity.

Debtor Turnover ratio =  This ratio measures how fast debts

Net credit sales
Average debtors
are collected.
 A high ratio indicates shorter time lag
between credit sales and cash
collection.

Creditor’s Turnover ratio =  A high ratio shows that accounts are

to be settled rapidly.
Net credit
purchases
Average Creditors
Sl. CATEGORY TYPES OF RATIO INTERPRETATION
No.
 This ratio indicates the
Debt-Equity ratio = relative proportions of debt
3. Capital and equity in financing the
Structure Ratios Long term debt assets of a firm.
shareholder₃s Equity
 A ratio of 1:1 is
considered safe.

 It indicates what
Debt to Total capital ratio = proportion of the
permanent capital of a
Long term debt firm consists of long-term
Permanent debt.
Capital

 A ratio 1:2 is considered

safe.

Or

Total debt  It measures the share of

Permanent capital + Current
liabilities the total assets financed
by outside funds.

 A low ratio is desirable

for creditors.

Or
′
Total Shareholder s Equity  It shows what portion of
Total Assets the total assets is financed
by the owners’ capital.

 A firm should neither

have a high ratio nor a
low ratio.
Sl.No. CATEGORY TYPES OF RATIO INTERPRETATION

Interest Coverage =  A ratio used to determine

how easily a company can
4. Coverage Earning before Interests and Tax pay on outstanding debt.
ratios interest
 A ratio of more than 1.5 is
satisfactory.

Dividend Coverage =  It measures the ability of

firm to pay dividend on
Earning after tax preference shares.
Preference Dividend
 A high ratio is better for
creditors.

Total Coverage ratio =  It shows the overall ability

Earning before interests and tax
Total &ixed charges
of the firm to fulfill the
liabilities.
 A high ratio indicates better
ability.
Sl. No. CATEGORY TYPES OF RATIO INTERPRETATION

 It measures the profit in

5. Profitability Gross Profit margin = relation to sales.
ratios
Gross pro&it ∗ 100  A firm should neither have
Sales a high ratio nor a low ratio.

Net Profit margin =

 It measures the net profit of
Net Pro&it after tax before interest a firm with respect to sale.
Sales
Or  A firm should neither have
a high ratio nor a low ratio.
Net Pro&it after Tax and Interest
Sales

Or
Net pro&it after Tax and Interest
Sales

Operating ratio =  Operating ratio shows the

6. Expenses operational efficiency of the
Cost of Goods sold + other
ratios expenses business.
Sales
 Lower operating ratio
shows higher operating profit
and vice versa .

Cost of Goods sold ratio =  It measures the cost of

goods sold per sale.
Cost of Goods
sold
Sales

Specific Expenses ratio =  It measures the specific

expenses per sale.
Speci&ic Expenses
Sales
Sl.No. CATEGORY TYPES OF RATIO INTERPRETATION

7. Return on Return on Assets (ROA) =

Investments  It measures the
Net Pro&it after Taxes ∗ 100 profitability of the total
Total Assets funds per investment of
a firm.
Or
(Net Pro&it after Taxes + Interest) ∗ 100
Total Assets

Or
(Net pro&it after Taxes + Interest) ∗
100
Tangible Assets

Or
(Net Pro&it after Taxes + Interest) ∗ 100
Total Assets

Or
( Net Pro&it after Taxes + Interest) ∗ 100
Fixed Assets

Return on Capital Employed (ROCE) =

(Net Pro&it after Taxes) ∗ 100  It measures

total capital employed
Or
(Net Pro&it after Taxes + Interest) ∗ 100
Total Capital Employed
Or
(Net Pro&it after Taxes + Interest) ∗ 100
Total Capital Employed − Intangible assets
profitability of the firm
with respect to the total
capital employed.
 The higher the ratio,
the more efficient use
of capital employed.
Sl.No. CATEGORY TYPES OF RATIO
Return on Total Shareholders’ Equity =
Net Pro&it after Taxes ∗ 100
Total shareholders equity
Return on Ordinary shareholders equity =  It determines whether the
Net pro&it after taxes and Pref. dividend ∗ 100 return for its equity holders
Ordinary Shareholders Equity
Earnings per Share (EPS) =
Shareholder’s Net Pro&it of Equityholders
8. ratios Number of Ordinary Shares
Dividend per Share (DPS) =
Net pro&its after interest and preference
dividend paid to ordinary shareholders
Number of ordinary shares outstanding
Dividend Payout ratio (D/P) =
Total Dividend To Equityholders
Total net pro&it of
equityholders
Or
Dividend per Ordinary Share
Earnings per Share
INTERPRETATION
 It reveals how profitably
the owner’s fund has been
utilized by the firm.
firm has earned satisfactory
or not.
 It measures the profit
available to the equity
holders on a per share basis.
 It is the net distributed
profit belonging to the
shareholders divided by the
number of ordinary shares.
 It shows what percentage
share of the net profit after
taxes and preference
dividend is paid to the equity
holders.
A high D/P ratio is preferred
from investor’s point of
view.

Earnings per Yield =
Earnings per Share
Market Value per Share
Dividend Yield =
Dividend per share
Market Value per share
Price- Earnings ratio (P/E) =
Market value per
Share
Earnings per Share
Earning Power =
Net pro&it after Taxes
Total Assets
Inventory turnover =
9. Activity Ratios
Sales
Closing Inventory
Raw Material turnover =
Cost of Raw Material used
Average Raw Material Inventory
Work in Progress turnover =
Cost of Goods manufactured
Average Work in process inventory
Debtors turnover =
Cost of Goods manufactured
Average Work in Process Inventory
 It shows the percentage of
each rupee invested in the
stock that was earned by the
company.
 It shows how much a
company pays out in
dividends each year relative
to its share price.
 It reflects the price
currently paid by the market
for each rupee of EPS.
 Higher the ratio better it is
for owners.
 It measures the overall
profitability and operational
efficiency of a firm.
 It measures how quickly
inventory is sold.
 A firm should neither
have a high ratio nor a low
ratio.
 It shows how quickly
current assets i.e receivables
or debtors are converted to
cash.
 A firm should neither have
a high ratio nor a low ratio.
Sl. No. CATEGORY TYPES OF RATIO INTERPRETATION

Total Assets turnover =

10. Assets Turnover  It measures the efficiency of a
Ratios Cost of Goods Sold firm in managing and utilizing
Total Assets its assets.

Fixed Assets turnover =  Higher the ratio, more

efficient is the firm in utilizing
Cost of Goods Sold its assets.
Fixed Assets

Capital turnover =

Cost of Goods Sold

Capital Employed

Current Assets turnover =

Cost of Goods Sold

Current Assets